Licensee Economic Update – June 2014

In Australia, the Federal government delivered a Budget which was designed to address the nation’s fiscal problems. However, much of the reaction to the Budget has comprised mixed opinions about whether it goes far enough or too far, while the political situation makes it highly uncertain as to which parts of the Budget will ever make their way through Parliament. This, coupled with the government’s general downbeat on the country’s outlook is having an adverse impact on both consumer and business sentiment. At face value this sentiment increases the chance of the Reserve Bank leaving the cash rate at current levels for a longer period of time. At its meeting on 3 June, the Board of the Reserve Bank decided to keep the cash rate steady at 2.5%.

Survey data from around the world shows ongoing positive economic momentum among the developed market nations. In the Emerging markets rises were solid again and continue to impact portfolios.

Financial markets are closely watching the European Central Bank for signs of an easing of monetary policy following comments by ECB President Draghi that the Bank could take steps as soon as June to soften the Euro and stave off disinflationary pressures within the Eurozone. European Parliamentary elections delivered strong results for anti-European Union parties, but this is likely to be of little material impact unless it is repeated in national elections.

Latest manufacturing data in China came in stronger than expected. Conditions in Ukraine remain volatile amid elections and ongoing violence.

Figure 1: Volatility fell sharply in May as equities edged their way higher

Australia

In Australia the big news in May came from the Federal Budget. For many people it is probably fair to say the Budget has proved to be an exercise in disappointment. Although the Government has taken steps towards addressing Australia’s fiscal problems, it seems to have done so in a less effective fashion than the markets had been hoping for. Furthermore, the Government’s subsequent inability to sell its Budget message in the lead up to the transition to the new Senate has done nothing to support confidence among businesses or households. Indeed, recent press reports suggest the business sector is becoming increasingly frustrated with the Government’s progress in getting necessary reforms under way.

The budget represents an overall drag on the economy of about $36 billion over the four years to 2017/18. In itself, this is not that large a drag on economic growth (less than 1% of GDP). However, real disposable household income will be affected by measures reducing welfare payments, increasing cost of living items such as petrol and Medicare, as well as the 2% deficit levy.

Coming after the dire warnings associated with the Audit Commission’s review of the nation’s finances, it is not surprising that consumer sentiment has deteriorated in recent months. This is illustrated in Figure 2, which shows a sharp decline in consumer confidence about family finances in the next 12 months. Combined with deteriorating household expectations about unemployment, it would not be surprising to see these sentiment indicators reflected in weaker consumer spending in coming months.

Figure 2: Households are feeling less comfortable about their financial situation

As noted above, sentiment in the business sector has
not been immune to budget politics. Business is frustrated that the government
has not proved more effective at introducing the necessary programme of reforms
while opposition parties in Parliament seem to display more interest in process
than in results. The risk is that this adverse sentiment flows through into
businesses scaling back their planned operations.

In tune with this, Figure 3 shows latest data for forward business orders declining sharply. This is a useful short-term leading indicator of capacity utilisation in the manufacturing industry, which in turn is one of the variables the Reserve Bank watches when making decisions about where to set the cash rate. If forward orders decline further and capacity utilisation follows suit then, all other things being equal, this would be a sign that the Reserve Bank could keep the cash rate unchanged for a longer period of time.

Despite the pessimism being portrayed by Government, the latest labour market data showed employment rose by 14,200 in April – all of which was in full-time jobs. One can’t but imagine what an upbeat Government would be saying and what impact it would have on sentiment. The participation rate fell ever so slightly in the previous month and the unemployment rate was unchanged at 5.8%. Conditions in New South Wales contributed a significant amount of the improvement in employment.

Rest of World

The Organization for Economic Cooperation and Development said it expects the emerging economies to provide some trade to global economic growth in the coming year but that improvement in the developed market economies should help deliver better overall conditions than in recent years. The latest survey data from the IFO shown in figure 4 illustrates improving economic momentum across North America, Japan and Western Europe. The same data for emerging economies shows marked deterioration in Latin America, some peaking of conditions in Asia and some improvement in Eastern Europe. This is at odds with market returns with ‘global’ emerging markets and re-emphasises the need for country specific views.

Figure 4: Ongoing momentum in developed world economic growth

United States

The United States economy is at long last moving past the adverse effects of the very poor weather at the start of the year. Snapshot has covered this for the last few months. Recent positive indicators include:

Housing starts rose 30.2% in April, much – this is higher than 3% expected by the market;

New home sales rose 6.4% in April;

Unemployment insurance claims fell to the lowest level seen since 2007;

durable goods orders in April improved slightly more than had been expected;

The Conference Board’s measure of consumer confidence rose to 83.0 in May from 81.7 in April.

It is too early to say whether recent inflation data will influence the Federal Reserve’s decisions about what to do with interest rates in the USA. Although economists have noted various senior officials have been making comments suggesting that interest rates could be increased – sooner than the markets expect. The Reserve Chairman Janet Yellen still seems to favour leaving interest rates where they are.

Europe

In Europe, the markets are waiting to see if the European Central Bank will take steps to ease monetary policy conditions further in order to stave off disinflationary pressures, especially through weakening the Euro. ECB President Draghi has said that the Bank could act as soon as June to take steps which might include setting negative interest rates on bank deposits with the ECB. Some recent economic indicators have shown a slight softening of conditions in Germany but further improvement in Spain. European Parliamentary elections delivered strong results for anti-European Union parties, but this is likely to be of little material impact unless it is repeated in national elections.

Meanwhile over in the United Kingdom the economy is continuing to improve quickly enough to suggest that the Bank of England may begin lifting interest rates as soon as early 2015. Isn’t this a surprise to the outlook some 18 months ago when so called green shoots were being talked about? The current UK unemployment rate of 6.8% is below the 7% threshold which the Bank of England had flagged as a barrier to higher interest rates. As with all countries, Governments are balancing growth and employment with interest rate movements – but it feels peculiar to increase rates following such a sustained global crisis.

China

In China the consumer price index rose 1.8% year to April which was slightly less than expected. The purchasing managers’ index rose to 50.8 in May after 50.4 in April – this was slightly better than expected and followed HSBC’s “flash” update in April which was lower. Chinese data remains a mystery to most but the news continues to impact short term nervousness in markets. The message with China has always been around a controlled growth pattern above mature economies and it is this growth that stimulates optimism here in Australia. Once again the above mentioned improvement has been attributed to recent stimulus measures by the government. Two weeks ago the authorities said they would cut the reserve requirements of selected lenders after reports of price declines in selected real estate markets. One can’t help but fear the downturn in the property market in China once we have completed a life cycle of growth. It may not appear for many years due to masking of data and it may well be that it smooths out, however the impact on the rest of the world is frightening to say the least.

This has been prepared by Paragem Pty Ltd [AFSL 297276] and is intended to be a general overview of the subject matter. It is not intended to be comprehensive and should not be relied upon as such. We have not taken into account the individual objectives or circumstances of any person. Legal, financial and other professional advice should be sought prior to applying the information contained above. Advice is required before any content can be applied at personal level. No responsibility is accepted by Paragem or its officers.

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